Carbon pricing policy, revenue recycling schemes, and income inequality: A multi-regional dynamic CGE assessment for China

Abstract

Carbon pricing policies are effective tools for mitigating carbon emissions; however, they also alter income distributions. Progressive individual income tax systems help redistribute income and reduce inequality. This paper evaluates the effects of carbon pricing policies and revenue recycling schemes on inequality and assesses the redistributive effects of individual income tax. We adopt a dynamic multi-regional CGE model and extend it in terms of the labor supply, tax revenue, and government expenditures. We obtain several key findings. Carbon pricing without revenue recycling increased income inequality, and the Gini coefficient was 0.59% and 1.88% higher than the benchmark in 2030 and 2040, respectively. When the revenue was recycled via individual income tax returns, the proportional recycling scheme, i.e., all income groups had the same tax return rate, continued to widen the income gap. The progressive recycling scheme, i.e., lower income groups received higher tax return rates, narrowed the income gap by reducing distortions in the economy and enhancing the redistributive effects of individual income taxes. The Gini coefficient was 0.34% and 0.71% lower than the benchmark in 2030 and 2040, respectively. If the central government allocated the carbon revenue to the local governments via general transfer payments, the redistributive effect was magnified, but a pronounced economic distortion widened the income gap. If the tax return rates were categorized by labor groups, the pronounced vertical effect of the redistributive effect benefited income equality most, while the reranking effect weakened that benefit.